MF Global’s original sin

Experienced players know that the outcome of a game of chess often is determined in the opening moves, just as it is with many military battles or legal contests for assets, control and influence. It’s the way the world works.

So, were MF Global customers up against a stacked deck from the beginning? When MF Global Holdings attorney Kenneth Ziman went to court the day after the firm declared Chapter 11 bankruptcy, he appeared in front of Judge Martin Glenn, whom he had worked with previously at a law firm. The judge asked his former colleague: “I’ve read a number of stories that deal with alleged shortfalls in customer property. Is that only in the registered broker-dealer?” Ziman answered, “All funds are accounted for, and I’m talking about the broker-dealer.” With that, Judge Glenn said, “Okay.”

No one, including regulators in attendence, disputed this misstatement or outright lie, and from then on, MF Global Inc. brokerage customers were on their own.

Sunday in the office with Jon

On Sunday, Oct. 30, 2011, the filing for the eighth largest bankruptcy in U.S. history, MF Global Holdings, Ltd., had to be finalized. Attorneys for the firm worked through the night against the clock in consultation with major creditors and regulators, including the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC).

Earlier that week, MF Global Chairman and CEO Jon Corzine had tried desperately to find a buyer for its brokerage unit, MF Global Inc., while attempting to raise cash for the holding company. Selling the dually registered futures commission merchant (FCM) and broker dealer (with its 318 securities accounts) might save the company and enable it to re-organize. The brokerage unit was by far MF Global’s largest and most viable asset, and the cash from the deal would help stop the hemorrhaging.

There had been a number of possible white knights in the days leading up to the bankruptcy. Corzine contacted his old firm Goldman Sachs, which outright rejected the deal. JPMorgan (the largest creditor to MF Global Holdings) reviewed a purchase and decided against it, stating it did not fit their business. But Interactive Brokers (IB) was very interested, and the only one to make a bona fide offer. It had missed an earlier opportunity when Man Financial (which became MF Global) bought the bankrupt Refco in 2005.

With the Sunday night marathon of conference calls among executives, attorneys and regulators buzzing in the background, all were expecting a sale of MF Global Inc. IB’s accountants and lawyers pored through drawers, filing cabinets and computers as part of their final due diligence. Then a shortfall of $633 million in customer funds was discovered (later upped to more than $1.2 billion) and that put an end to the IB offer.

At first, MF Global executives claimed it must be an error, but after a frantic search for the money, they acknowledged it had been transferred out of the firm. With the shortfall confirmed, the clock now was ticking faster, and lawyers and executives hastily moved to complete the bankruptcy preparations.

On Monday morning, Oct. 31, MF Global Holdings filed for a Chapter 11 bankruptcy and, later the same day, the Securities Investor Protection Corporation (SIPC) filed for protection and liquidation rights over MF Global Inc. The futures industry had experienced brokerage bankruptcies before, but on this day events were to unfold as never before in the industry.

Under court order, access to exchanges and accounts was blocked, creating unlimited risk to customers and later forcing massive losses and liquidations by moving positions, such as long options, with inadequate underlying capital.